HIH collapse: another case of socialising the losses?

by Colin Teese

News Weekly, June 2, 2001

Colin Teese sees the HIH collapse and bail-out proposals as characteristic of the current economic mania. In the drive for profits, government regulation is eschewed yet, when things go bad, corporations expect a taxpayer-provided life-line.

News Weekly readers will need no reminding of this writer's view that uncontrolled market forces aren't the best means of ordering either the economy or society.

The most recent victim of that system of economic organisation is the insurance giant HIH - casualty, so it appears, of debilitating and wasteful competition aimed at the demolition of rivals that, in the end, turned upon HIH itself. It may well take Mr Howard's government down with it.

It was interesting to observe the response of the Financial Review - Australia's journal of record in matters of globalisation and deregulation - to these developments.

Its first pose was one of benign indifference. Then, as reality closed remorselessly in, even the Review could not avoid the conclusion that HIH's demise carried with it disturbing and inescapable implications: and that these reached beyond the industry itself, deep into the wider community.

The Review did not respond at all well to these realities. Not knowing quite which way to jump, it was, nevertheless, certain about one thing - the insurance industry itself was under no obligation to clean up the mess.

Still less could the newspaper bring itself to advance the idea of a government rescue. (Note, incidentally, that health and other social and welfare outlays are always at the 'taxpayers' expense': corporate welfare, by contrast, is a charge on 'government'.) As always, perceptions count.

What can be said with certainty was that issues like the HIH collapse draw us well and truly into the area of what economists, and some others, like to call "moral hazard". That condition is said to exist when commercial enterprises are, for whatever reason, in a position to ignore prudent risk assessment, safe in the knowledge that governments (or - more accurately - taxpayers) cannot avoid some measure of bail-out.

Banks have traditionally enjoyed this kind of protection, though for the most curiously illogical reasons.

Taxpayers might legitimately be asked to rescue, for example, certain of a troubled bank's depositors, but not, so the argument goes, its shareholders. Totally overlooked in this analysis is the fact that, if as a result of protection of deposit-holders, a bank survives which would otherwise have gone under, then benefit to shareholders becomes an incidental consequence of rescuing depositors.

In any case, insurance falls into a slightly different category. For example, there has been no question of saving HIH. "And quite rightly so", many will say, though one is tempted to ask: why the difference between banks and insurance companies?

Whatever the answer to that question, the more important issue is - bank or insurance company - why should there be a different attitude towards depositors and policyholders on the one hand, and shareholders on the other?

Despite the contradictions, a ramshackle and informal kind of policy has been distilled to cover these circumstances. Taxpayer bailing-out of "regulated" enterprises (usually financial enterprises) was justifiable, at least for certain categories of losers from actions of corporate irresponsibility.

Insurance policyholders (as with small depositors in banks) were to be regarded as "innocent" victims of mismanagement and corporate failure and therefore worthy of help. Shareholders were, however, in a different category. After all, their aim was to make a profit.

The logic, let alone the equity, of this distinction escapes at least this writer. After shopping around, does not the insurance policyholder (or bank depositor) select which of the available enterprises, to bless with his or her custom? Presumably, the is made upon a perceived advantage - financial or otherwise.

How is this different from the attitude of an investor choosing to buy shares in the same enterprise? Informed choices about where the best financial advantage lies are behind the decisions in either case.

So, why the different treatment?

Quite simply, politics. Governments believe they can ignore shareholder losses, while ever the underlying, unspoken assumption is that shareholders are rich, and small depositors and insurance policy holders comprise mainly little old ladies and widows and orphans, along with low-income families.

If this was ever true it certainly is no longer. And, in any case, it is surely a dangerous assumption for a Liberal/National Coalition that advocates widespread shareholding as one of its policies.

That same Coalition is also a supporter of a deregulated financial system and enforced, universal and self-funded superannuation. As operated in Australia, that form of compulsory self-funded welfare, draws low-income workers - probably unwittingly - into the ranks of shareholders.

Almost to a man - and woman - this new class of investors are at least as vulnerable as the depositors in banks and policyholders in insurance companies. And their precious enforced savings are channelled into private investment houses operating in a highly competitive environment, with all the risks that entails.

Ideally, these compulsory savings should be managed by non-commercial, government-supervised investment agencies. At the very least they should be governed by the strictest operating rules.

In fact, the opposite applies. Many of the shares now held, either directly or through superannuation funds, by low-income families or individuals, are in enterprises which are no longer regulated in ways which give both shareholders and others associated with their activities, adequate protection against financial loss. It was not always so.

Banks, it will be recalled, were required to maintain "reserves" which could be called upon as necessary. Insurance companies, were mutual societies owned by policyholders rather that public companies, and, as such, were required to invest specified proportions of their holdings in safe government paper.

Guarantees

These safeguards amounted to a virtual prescription against improvident or excessively risk-oriented business practices by financial institutions. Banks and insurance companies were also further insulated against excessive risks by virtue of company cultures, which entailed lifetime attachment to the companies by loyal and thoroughly trained staff. Fall-back provisions for government intervention also existed, though they were hardly ever called up.

Banks and insurance companies have been relieved of almost all regulatory obligations in the process of deregulation - in the interests of allowing them to survive the impact of financial deregulation of Australian financial markets.

It is as if the lesson had never been learned that, human nature and business competition being what it is, we cannot rely on management to hold to prudent practices in the face of threatening competitive pressures.

Managers and directors, in the finance areas, as elsewhere, will do what it takes, in the short term, to hold competitors at bay; because, if they don't, for them there will be no long term. That reason alone demands that effective safeguards be kept in place.

So what can, and should, be done?

There are three possible safeguards - all of which should be put in place.

First there should be severe penalties applicable to management for reckless, irresponsible and illegal commercial behaviour. Not financial penalties, because they can easily be avoided, but prison sentences.

Second "regulations" of a safeguarding nature of the previously existing kind should be re-imposed, and possibly tightened.

And third, and perhaps most important of all, there should exist the alternative - for those who prefer to trade security against risk - to seek the safer haven of non-commercial banking and insurance facilities.